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Swap Vote to Trigger New Rules

Regulators’ decision this week on how to define a swap will trigger a cascade of Dodd-Frank changes.

When they decide which derivatives are considered swaps under the Dodd-Frank Act, U.S. regulators will unleash a cascade of rules on the $648 trillion global market designed to prevent a repeat of the 2008 credit crisis.

The Commodity Futures Trading Commission is poised to complete several hundred pages of regulations tomorrow that determine when trades by JPMorgan Chase & Co., Goldman Sachs Group Inc., Cargill Inc. and other companies must fall under rules to reduce risk and increase transparency. The Securities and Exchange Commission unanimously approved the rule July 6 without holding a public meeting.

“It’s really very critical to complete the further definition of the word swap and the end-user exception,” CFTC Chairman Gary Gensler said in a telephone interview on July 5. “Those are foundational rules.”

Dodd-Frank required the two agencies to write scores of regulations to govern swaps reporting, record-keeping, trading, collateral and other issues. The agencies missed the July 2011 deadline for implementing the changes and have repeatedly announced further delays.

“All of these regulatory requirements depend on a derivative being defined as a swap in the first place,” said Lynn Stout, professor of law at Cornell University. “The definition of swap is the critical underpinning of the success of the regulatory regime.”

The U.S. agencies are striving to meet an end-of-year deadline set by Group of 20 member nations to improve market oversight in response to a credit crisis that led to the collapse of Lehman Brothers Holdings Inc. and U.S. bailouts of companies including American International Group Inc. Getco LLC, Citadel LLC and a group of proprietary traders, hedge funds and other asset managers have urged the CFTC and SEC to complete rules requiring clearing of trades before next year.

The CFTC also will exempt banks with $10 billion or less in assets from requirements to guarantee swaps at central clearinghouses, according to two people briefed on the matter who requested anonymity because the rule hasn’t been made public.

The swap definition will trigger almost 20 Dodd-Frank changes to the market over the coming months. Within two months of the definition’s publication, swap dealers and so-called major swap participants must register; the CFTC estimates that 125 companies will be required to do so. Data on interest rate and credit swaps must be reported to the public starting within two months of the swap definition.

Conduct Standards

Regulations governing conduct standards between banks and swap-buyers, internal standards for chief compliance officers and registration for swap-data repositories are also pegged to the final definition vote. Rules for agricultural swaps and commodity options also rely on the swap definition.

Limits mandated by Dodd-Frank on speculation in oil, natural gas, wheat and other commodities will also begin to take effect two months after publication of the swap definition. The so-called position limits, facing a court challenge by Wall Street trade associations, will start to take effect on contracts in the current, or spot, month.

“This is a key rule because once this definitions domino drops, others will fall into place pretty quickly,” Bart Chilton, a Democratic CFTC commissioner, said July 6.

The limits spurred more than 13,000 comments to the agency from supporters such as Delta Air Lines Inc. and opponents such as Barclays Plc. The International Swaps and Derivatives Association Inc. and Securities Industry and Financial Markets Association filed a lawsuit in December seeking to overturn the limits, arguing that the agency didn’t demonstrate that they were required by the law. The groups also argued that the CFTC failed to conduct an adequate analysis of the costs and benefits before approving the regulation.

A ruling is pending from U.S. District Judge Robert Wilkins.

The case is International Swaps and Derivatives Association v. U.S. Commodity Futures Trading Commission, 11-02146, U.S. District Court, District of Columbia (Washington).

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